By Daniel Cash
The writer is Associate Professor at Aston University and Senior Fellow at the UN University Centre for Policy Research
NEW YORK | 30 January 2025 (IDN) — Africa is in a debt crisis. On the continent, interest payments on debt have risen by 132% over the past decade. Thirty-two African countries now commit more to servicing debt than they do investing in healthcare, and 25 spend more on debt than education. In September, UN Secretary-General António Guterres warned about the potential of social unrest across Africa due to lack of access to effective debt relief. Past debt crises in Africa have been met with internationally co-ordinated responses, but this time, similar efforts have failed.
At the root of this debt crisis is a credit-rating crisis. To resolve it, Africa’s international partners urgently need to place credit rating agencies on the global agenda – and under a microscope.
How did we get here? The rise of private creditors
Since the COVID-19 pandemic, African countries have faced a shortfall in official development assistance (ODA) grants and loans. To make up that shortfall, the developed world advised them to turn to capital markets and their array of private creditors like pension funds, insurance funds and wealth managers.
Today, these private creditors are the main source of financing for Africa’s sovereign debtors.
There are two major problems with this arrangement. First, due to a raft of internal rules and external laws, the agents who manage the creditors’ investment are forced to prioritise the position of the principal, not the target of the investment. This discourages private creditors from participating in debt treatment initiatives in which reductions are applied to original debt agreements.
Second, creditors rely heavily on international credit rating agencies (CRAs) to understand the potential risk in their investments. This has made CRAs critical to Africa’s financial health. But CRAs exist to help private creditors understand whether they will receive their investment back on time and in full. If those two aspects are even remotely threatened, the CRA is legally required to reflect that threat to the private creditor in the rating of the debtor. Usually, that results in an instant downgrade to default status. Once this happens, a sovereign debtor cannot re-enter capital markets until they come out of that rating level. Even if the time spent in the default rating level is short, the reputational damage can be significant.
Debt treatment initiatives — a mixed bag
Since 2020, debt treatment initiatives like the Debt Service Suspension Initiative (DSSI) and the Common Framework have sought to provide relief to countries with both their official debt (debt owed to other countries and multilaterals, which CRAs do not consider) and private debt. Both G20 initiatives, the DSSI aimed to suspend debt servicing to provide instant flexibility, while the Common Framework aimed to provide a formal structure to increase the speed of debt restructuring. One feature of these initiatives is ‘comparable treatment’, which requires a debtor to agree the same terms with both official and private creditors. As this would force losses on private creditors, participation in those initiatives carries the risk of being downgraded to default.
Results are mixed. Countries only participated in the DSSI once it was clarified that comparable treatment was not an official requirement. To date, only four countries have participated in the Common Framework—where comparable treatment is required. Of those countries, three were already in default, and one was unrated.
What is the path forward?
One potential solution is to create a global regulator to enable better representation of developing economies, promote the global comparability of ratings, and enforce greater disclosure from credit rating agencies. Another is for CRAs to be more transparent about the qualitative elements of their ratings—such as the effectiveness of institutions or standards of governance—which could highlight subjectivities on the part of ratings analysts. Agencies could also publish analyses simulating debt dynamics—for example, factoring in climate transition pathways—and examining their effect on credit ratings.
African countries must also be represented on the credit rating committee of the International Organization of Securities Commissions (IOSCO), which would inject African representation into the standard-setting body for the industry. And CRAs must be required to publicly declare what public information they are using for every sovereign credit rating they produce. This would provide countries with more insight into how they are being rated. Absent this, countries are less able to predict what data are most useful to credit rating agencies. To date, CRAs have only been encouraged to do this, not required.
In the meantime, African governments have been busy. The African Union is making plans for its own public credit rating agency, the Africa Credit Rating Agency (AfCRA), which has the potential to provide a benchmark against which other ratings can be judged. As the AfCRA may be able to obtain better information from African countries, its ratings may be considered more accurate. And the AU is working with a newly-launched UNDP capacity-building initiative to better understand the inner workings of CRAs. The initiative coordinates training in partner countries and provides access to expertise from former credit rating agents.
The world has changed, and African countries need help navigating today’s global capital markets. Seeking to change the credit rating system has its limits. Instead, Africa’s international partners must step up support for capacity-building initiatives and work collaboratively to level the playing field. [IDN-InDepthNews]
Original link: https://oecd-development-matters.org/2024/12/06/to-fix-africas-debt-crisis-reform-credit-ratings/
Image source: AlexBarcley, Pixabay